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Sensitivity analysis Infrastructure investment: investment in transport infrastructure is assumed to have the same marginal product as that of private investment. All other infrastructure investment (environmental infrastructure, telecommunication infrastructure, urban rehabilitation, social infrastructure and health) is assumed to be only half as productive Human capital: educational investment is assumed to have the productive impact as described in section 4.3 above, all other human capital investment (labour market programmes, social inclusion, entrepreneurship and actions for women) is assumed to have only half the productive impact Productive environment: investment support leads to a higher capital stock, but R&D investment has only half the impact on TFP as assumed in the first scenario

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Absorption problems – e.g. Herve and Holzmann (1998) Waste of transfers. Due to lack of adequate administrative environment, transfers may used for investment projects with zero or negative economic return. Administrative costs to ensure the best possible use of transfers. Extra resources needed for programming and monitoring that cannot be used for increasing the productive capacity of the economy. This should at least seek to avoid waste of transfers, and aim to avoid sub-optimal use Rent-seeking activities Transfers provide an incentive to economic agents in public and private sector to invest resources in directly unproductive activities to catch a rent in the form of a share of the transfers. Competition for resources absorbs resources that can no longer be used productively Diversion of funds to consumption Positive income shocks affect consumption-investment decision of private and public sectors. Because of consumption-smoothing behaviour, the increase in future consumption possibilities will lead to a higher consumption on impact, to the detriment of investment

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Flexible Exchange Rate (PL): independent monetary authorities (inflation targetting) in short run more restrictive: higher nominal interest rates to dampen short run demand expansion in long run : nominal exchange rate depreciation to gain competitiveness Fixed Exchange Rate (LT): (Euro area, currency board, fixed pegs): in short run less restrictive: no interest rate response, higher inflation in long run : in order to gain competitiveness (real exchange rate depreciation) a period of disinflation is required (lower GDP effects)

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Conclusions Long run gains from investment in infrastructure, human capital and R&D (Lisbon Strategy) Short run positive demand impact (but considerable crowding out) Costs to donor countries : increase in EU budget contributions (redistribution) But these GDP losses for donor countries are mitigated by gains in net exports Exchange rate regime matters: countries with fixed exchange rate may have larger short run gains, but they need period of disinflation to gain competitiveness

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Conclusions (contd) Short run demand impact may lead to further overheating of already overheated economies These simulations assumed optimal efficient productive use of transfers (too optimistic ?) Potential absorption problems leading to lower efficiency: –Rent seeking –Protectionism –Market rigidities How can such efficiency losses be minimised? Reference: The Potential Impact Of The Fiscal Transfers Under The EU Cohesion Policy Programme, European Economy, Economic Papers, no. 283, June 2007 http://ec.europa.eu/economy_finance/publications/economic_papers/2007/economicpapers283_en.htm